Posted on 02/04/2022

How Are Mortgage Rates Determined?

5 minute read

The last few years have been a rollercoaster ride for mortgages and home buying. Spurred on by the global pandemic, the market now has the most first-time home buyers in history.

If you are one of those first-time buyers, how do you predict mortgage rates?

What's in this article?

Breaking it Down
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Personal Factors
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Credit Score
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Down Payment
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Occupancy
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Taking Cash Out
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Market Factors
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Federal Reserve
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Inflation
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Secured Overnight Finance Rate
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Economic Health
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Bond Market
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Constant Maturity Treasury Rates
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Finding a Mortgage
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Knowing what influences them can be confusing, but don’t fret. Allow us to give you some insight into how mortgage rates are determined.

Breaking it Down

Mortgage rates are determined by a number of factors. Some have to do with the wider economy, while others are more concerned with your own personal standing. When discussing what determines them, it is easier to break them down into these two camps.

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Personal Factors

Personal factors are ones that you can control. You have the ability to make changes in your circumstances that will result in a much better rate.

Credit Score

All loans are influenced by your credit score, regardless of them being a mortgage loan or not. A mortgage lender needs to know that the loan will be repaid. Your credit score is an indicator that helps them decide on your reliability.

When your credit score is high, it shows you have a history of making payments on time. This bodes well for the lender, and they will give you a better rate. If the credit score is low, then the risk increases, and higher rates are applied.

Down Payment

The higher the amount mortgage companies have to loan you, the more risk is involved. By reducing the risk, you can get a better deal. When you have a higher down payment, they need to loan you less money, and are more likely to give a favorable rate.

If your down payment is less than 20% then you are often required to have mortgage insurance. You can choose between lender-paid mortgage insurance or borrower-paid. When you choose the first, your mortgage rate is higher.

All of this gets calculated using a loan to value ratio. This is the total value of the property minus the down payment you have paid. The higher the LTV ratio, the more risk is involved with over 80% being a high-risk loan.

For example, imagine you buy a property that costs $100,000 with a $10,000 deposit. Your down payment is worth 10% of the value of the overall property, making your LTV ratio 90%. This would be a high-risk loan.

Occupancy

How the home is occupied also impacts the mortgage rate. Once again this comes back to risk. If you have a property that is for rent, and you run into financial difficulty, you are much more likely to pay the mortgage on your primary home.

Taking Cash Out

Converting the equity in your property will also result in higher rates. In doing this, you end up with a higher amount than you had when going into the borrowing process. As such, the risk for the lender increases, raising your mortgage rate.

Market Factors

Market factors are the national and global financial factors that influence your interest. These are out of your control.

Federal Reserve

In the US, many people think that the Federal Reserve sets mortgage rates. They do not, but what they do has a direct impact.

The Federal Reserve will manage short-term interest rates. In times of economic downturn, the reserve will lower interest rates. These rates are related to the amount banks can borrow, which they can then lend to their customers.

Doing this means the supply of money increases, people have more to spend or invest, and the economy booms. When they raise the rate to increase control of the money supply, then lenders have to follow suit.

Inflation

If the prices of goods, products, and services rise, the national currency of a country loses its buying power. To compensate, a mortgage lender will want higher interest rates. During times of low inflation, mortgage rates tend to stay static and change very little.

Secured Overnight Finance Rate

The Secured Overnight Finance Rate (SOFR) is a type of interest rate. It is used to determine the base interest rate of a mortgage. This all depends on the type of home loan that is being offered at the time.

Economic Health

The national economy is influenced by many variables. In times of prosperity, when people have more money, mortgage rates will increase. During times of economic downturn, mortgage rates will fall, to encourage more loans.

Employment is a good indicator of this. If a lot of people are out of work, spending becomes less. The economy slows and mortgages rates will fall.

Bond Market

Mortgage bonds are bundles of mortgages sold on the bond market. If the stock market is not performing well, then these bonds are in higher demand. Mortgage rates then increase. When they are not in demand, they will lower.

Constant Maturity Treasury Rates

Not all lenders will use this to determine their mortgage rate, and it will only impact adjustable-rate mortgages. Constant Maturity Treasury Rates (CMT) is a theoretical value, based on the yield of different treasury securities over different time scales.

This helps predict how the economy will perform over time. The One-Year Constant Maturity Treasury Index is the most widely used.

Finding a Mortgage

Now that you know how mortgage rates are determined you can start your search. Different lenders will offer you very different quotes, so shop around.

Your first stop for a mortgage company should be Compass Mortgage. We offer a personalized mortgage experience that will work around you. Contact us to discuss your needs and let us help finance your new home.

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